The last few weeks I have encountered quite some stock market predictions that were based on last year’s performance. Many of them sounded like this; ‘Because 2013 turned out to be such an extraordinary year, there is a big chance that 2014 will result in another good year for equities’. In a number of occasions the ‘big chance’ was quantified. BCA Research stated that years in which US equities rose 25% or more were followed by another positive year in 77% of the cases. Credit Suisse calculated it to be 78%.
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Now, while this is certainly a big number, the 25% itself is not that relevant. Take a look at the graph above. It shows the historical probabilities of a positive ‘Year After’ for different cohorts of positive returns in the year before. As can be derived, the size of the positive return in the first year does not give you much variation in the chance of a positive return the second year. After a year that returned 10% or more the probability has been 76%, only to rise by two percentage points if the return in the first year had been 30% or more. And, perhaps more important, those probabilities are only slightly higher than the overall chance of a positive year for equities, which has been 74%. Many years turn out to be positive for equity markets. The knowledge that we had an incredible 2013 does not increase your chances for 2014 all that much.
For further reading on what to expect for 2014 please follow this link.